Canadian Dollar Forecast: Geopolitics & Bank of Canada to Set the Tone for USD/CAD

(MENAFN- DailyFX) CANADIAN DOLLAR OUTLOOK: SLIGHTLY BULLISH

• Geopolitical tensions will continue to dominate near-term price action
• If the crisis in Eastern Europe subsides and sentiment improves, high-beta currencies such as the Canadian dollar could strengthen
• The bank of Canada's interest rate decision could also boost the loonie, pushing USD/CAD lower

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USD /CAD has been on a roller coaster ride in recent days amid heightened geopolitical tensions in Eastern Europe after Russia launched a military operation and began an unprovoked invasion of Ukraine. Against this backdrop, the pair briefly climbed to a two-month high of 1.2878 on Thursday before settling around 1.2735 ahead of the weekend.

Although oil prices have surged this year , with the West Texas Intermediate blend up 5% in February and up over 22% in 2022, the Canadian dollar (loonie) has been unable to take advantage of the situation, as high volatility and risk-averse sentiment have limited the appeal of high-beta currencies while boosting demand for safe-haven assets.

However, the situation could change in the coming days if the conflict between Ukraine and Russia eases. It is too early to tell how the crisis will unfold, but on Friday Moscow signaled a willingness to resume talks with the Ukrainian government, a sign that there is still a chance for diplomacy. Should hostilities abate, the Canadian dollar is well-placed to command strength in the near term, helped in part by improved terms of trade from higher commodity prices.

At the same time, Bank of Canada could accelerate USD/CAD's reversal lower in the days ahead if it delivers a hawkish interest rate hike on Wednesday when its March monetary policy meeting concludes. That said, the bank is expected to raise borrowing costs by 25 basis points to 0.50% to tackle red-hot inflation, which hit a three-decade high of 5.1% y/y in January, more than twice above the 2% mid-point target. Given that the move has been fully discounted, traders should focus on the language and forward guidance in the statement.

With overall economic slack absorbed in Canada, strong employment growth and mounting price pressures, BoC could suggest that the tightening cycle will be forceful, setting the stage for several hikes in the coming quarters. Investors currently see four interest rate increases in 2022, but the normalization path could reprice higher if policymakers take a tougher stance amid upside inflation risks. This scenario creates a bullish bias for the CAD.

From a technical perspective, if USD/CAD extends Friday's downswing and breaks below support near the 1.2700 psychological level, sellers could be emboldened to drive the exchange rate towards 1.2600, the 38.2% Fibonacci retracement of last year's June/December rally.

On the flip side, if bulls reemerge and regain control of the market, resistance lies at 1.2878, Thursday's swing high. If prices push higher and overtake this barrier, bullish impetus could strengthen, paving the way for a retest of 2021's high.

USD/CAD chart prepared using TradingView

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---Written by Diego Colman, Contributor

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